Rampant
deforestation in Central America has been problematic for decades, and its
impact on hydrological flows has become a major concern. In the late 1970s and
early 1990s, Costa Rica maintained one of the highest rates of deforestation
and experienced an estimated loss of about 35-40% of its forest cover (1). Much
of this loss occurred as a result of generating more land for agriculture and
pastures.

This decline in
forest cover and the increase in demand for water services have created immense
political pressure to curb deforestation in part because of the conventional
wisdom that forest ecosystems provide valuable hydrological services. As a
result, the Costa Rican government developed a program to provide a system of
payments for environmental services in order to promote reforestation.This revolutionary program called Pago
por Servicios Ambientales (PSA) was implemented in 1997, and it allows land
users to be compensated for the environmental services their land generates.

The main
objective of PSA is to correct the coordination failure that exists in the
market for forest environmental services so that the value of forest cover is
internalized.Two fundamental
problems plague this market. The first is that many land owners and users are
not directly compensated for the environmental services their forest creates.
If land users provide these services by not expanding pastures and farmland or
by participating in reforestation practices, they forgo profit their land could
create. Therefore, land users do not have any incentive to provide these
services. Secondly, those who use these services are at some distance from the
forests, which makes it difficult to understand the precise impact on them of
landowner decisions (1). Moreover, in many cases the beneficiaries of forest
services lack the facility to pay for the ability to maintain the supply of
these services.Consequently, this
coordination failure produces socially suboptimal land use.By attempting to compensate land users
for the services their forests create from revenues derived from the
beneficiaries, the PSA program aims to correct this coordination failure.

How does the PSA
program work? Landowner participants must present a sustainable forest
management plan that is certified by a licensed forester. The national agency,
Fondo Nacional de Financiamiento Forestal (FONAFIFO), collects, manages, and
negotiates the payments from those who receive the benefits from the water
services that forests provide.The
program then relies on Sistema Nacional de Areas de Conservacion (SINAC) to pay
and monitor the participants.

Under the Costa
Rican Forestry Law No 7575, hydrological services, including the provision of
water for human consumption, irrigation, and energy production, are explicitly
acknowledged as a service provided by forest ecosystems. This law, however,
does not require payment from those who benefit from the hydrological services
(1).

One of the
biggest problems for FONAFIFO in obtaining payments under the PSA program is
the total lack of any conclusive evidence on the extent to which forest cover
provides improved and/or sustained water services for hydroelectric power
(HEP), irrigation, and consumption.Some studies do provide a basic formula FONAFIFO uses to charge for the
water services, but this is not perfect (1).

Fortunately,
many HEP producers have been willing to participate in the program because the
changes in the forest ecosystems may threaten the current conditions (1).As a result, the PSA program has been
moderately successful in convincing at these water users to pay for forests’
water services.

Although
requests to participate in the PSA program exceed the resources available (2),
the important question is how effective and efficient has the program been in
eliminating socially suboptimal land use? Although the data are limited, the
PSA program appears to have had a greater impact on preventing deforestation
(82.5% of contracts) than reforestation (7% of contracts) (1). The general
consensus is that the program has improved the protection of Costa Rica’s
forests.The PSA program’s shift
away from a more universal payment system to a more targeted one in recent
years has helped improve the efficiency of this market. This shift in emphasis
allows the program to devote more resources to areas that create the most
valuable water services (1).Additionally, targeting the funds to their specific watersheds enables
the beneficiaries, especially HEP producers, to pay for services they actually
use, which helps eliminate free-rider incentives.

The lack of
reliable qualitative and quantitative information about the links between
forest cover and water services illustrates a large weakness in the program’s
effectiveness, efficiency, and sustainability.This lack of quality information makes it incredibly
difficult to determine the value of water services generated by forest cover.
In order for the PSA program to work effectively and efficiently it must pay
the suppliers no less than the opportunity cost for the other uses of the land,
but no more than the value of the benefit. However, it is important to be able
to determine where the value of the service is low and the opportunity cost to
society of forgone land use is high so that the program does not absorb
valuable land for society (1). Costa Rica faces a substantial cost of being
wrong for water payments that are either too low or too high. Without an
understanding of the value of the water services forest cover provides, it is
impossible to determine where and if the program is cost effective. Until
reliable information about the link between forest cover and water services
becomes available one must question the sustainability of the PSA program. The
PSA program possesses the necessary structure to generate an effective and
efficient market to promote socially optimal land use, but it is incapable of
completely correcting the suboptimal land use problem until it can accurately
value the forests’ environmental services.